Is the “new normal” actually that normal?
Someone asked me the other day if I’m still in the “double-dip” (recession) camp. That led to an embarrassing confession that while I once believed higher interest rates would choke off the nascent recovery, the current recovery has lasted long enough and remained strong enough that I think those of us who were double-dippers ought to confess to being wrong.
Do I think the current recovery eventually will turn down? Of course. But if it turns down next year or even next month, I think it’d be disingenuous for the double-dip campers to claim they accurately forecast this cycle.
In fact, thus far the “new normal” feels pretty normal when you look at the strength of the current recovery and study how the market has responded to these statistics.
The May-Investments Leading Economic Indicator remains strong, with eight of 10 indicators reflecting improving conditions. Even bank lending has turned up, if only barely, indicating that since banks have stopped buying Treasury securities, they now have enough funding available to pay both their exorbitant CEO bonuses and make the odd loan here or there to small businesses that desperately need it. While overly tight bank regulators remain focused on denying capital to just about anyone who might need it to do business, forestalling job growth and pushing former pillars of the community into the hands of better-financed Fortune 500 competitors, at least (statistically speaking) the banker problem has finally stopped getting worse.
The two current areas of concern are export growth, which seems to be stalling, and a bit of a slowdown in the technology sector, probably related to the economic trauma suffered by Japan and that could be affecting the greater Asia region. In any case, with 80 percent of the indicators improving, it’s hard to see why it makes sense to run for the hills. Economic growth appears to be real, significant and ongoing.
The Fidelity Market Analysis Research & Education group recently published an analysis that shows that from the perspective of the stock market, the post-recession recovery has followed a normal path. Early in the recovery, financials and consumer cyclical stocks led the way. Now, in the mid-cycle of this expansion, energy and industrials are leading the rally. The sector rotation we’ve experienced has thus far behaved exactly as a textbook on the investment cycle would’ve forecast.
Strictly observing sector performance, the failure of the banking sector to either write off or in any way digest its bad loans isn’t apparent. The de-leveraging of the consumer sector, and the degree to which many small business owners and consumers have been cut off from access to credit, doesn’t really show up. Nor has stubbornly high unemployment seemed to matter. As far as the market is concerned, the economy put in a typical V-shaped rally and robust expansion by businesses is leading to a resurgence in inflationary pressures, which would typically result in a modest mid-cycle rally in stocks, especially by the business sector.
I think “the market” is wrong. I think the banks put in a “dead cat bounce” where those banks that didn’t go belly up, beneficiaries of an enormous wealth transfer from savers and taxpayers to incompetent financiers, rallied strongly on a faked recovery in banking sector earnings. It restored consumer confidence, but the systemic cancer remains. I think that corporate America has taken important steps to cut costs, especially in the area of interest expense. But historically high profit margins seem out of step with the economic realities facing the country. Finally, I think that to the degree the market recovery was stoked by an end to distressed selling, mostly because bonds and cash no longer pay a competitive return (there’s no place else to go), today’s zero interest rate environment seems like an ingenious deception rather than a solid long-term rationale for investing in stocks.
But sometimes it’s best to keep the alternative scenarios in mind, especially if you’re writing only seven paragraphs after confessing to have blown it with a double-dip forecast. The investment business is, if nothing else, a humbling enterprise. I still expect inflationary pressures to get worse and interest rates to move high enough to shut down expansion. At that point, I believe today’s deferred problems will resurface so that the next cycle down will be severe — hopefully not as severe as 2008, but nonetheless a severe recession when put in historical context.
Let’s hope I’m wrong again.